Stephen Bainbridge's Journal of Law, Religion, Politics, and Culture

May 2006

05/31/2006

The early years of this century were not kind to investors. In 2000-2001, the stock market recorded back-to-back years of losses for the first time since 1973-74. When the market suffered a third consecutive losing year in 2002, it did so for the first time since the Great Depression. On top of the late 90s bubble bursting, came a string of bad news that further eroded investor confidence: Repeated accounting scandals, of which Enron and WorldCom are merely the most notorious. A high profile investigation by New York's attorney general calling into question the integrity of stock market analysts. And so on.

In response, Congress cobbled together the "Public Company Accounting Reform and Investor Protection Act" of 2002 -- popularly known as the Sarbanes-Oxley Act (SOX for short). As he signed it into law, President Bush praised SOX for making "the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt." Others have been less kind; Yale law professor Roberta Romano, for example, memorably called SOX "quack corporate governance."

Congress hoped SOX would restore investor confidence by curbing various corporate governance excesses, encouraging director independence from management, and especially by toughening up accounting standards so as to enhance capital market transparency and the integrity of disclosures. Whether any of these benefits have been achieved is debatable and, if so, any such benefits have proven almost impossible to quantify.

What is clear after four years experience with the Act is that the costs have been far higher than anyone expected. Worse yet, as I've documented in prior TCS columns, such as SOXing It to Small Businesses, those costs have been born disproportionately by small publicly held corporations.

In response to growing concern with the deleterious impact SOX appeared to be having on smaller firms, the Securities and Exchange Commission (SEC) set up an Advisory Committee to assess the affect SOX and other securities laws have on small public corporations. The Committee released its final report on April 23, 2006. In its report, the Committee concluded that the costs imposed on smaller public corporations by a number of key SOX provisions significantly exceeded any benefit those provisions provide investors.

In particular, the Committee focused on SOX § 404, which requires inclusion of internal control disclosures in each public corporation's annual report. This disclosure statement must include: (1) a written confirmation by which firm management acknowledges its responsibility for establishing and maintaining a system of internal controls and procedures for financial reporting; (2) an assessment, as of the end of the most recent fiscal year, of the effectiveness of the firm's internal controls; and (3) a written attestation by the firm's outside auditor confirming the adequacy and accuracy of those controls and procedures. The Committee explained that:

From the earliest stages of its implementation, Sarbanes-Oxley Act Section 404 has posed special challenges for smaller public companies. To some extent, the problems smaller companies have in complying with Section 404 are the problems of companies generally:

lack of clear guidance;

an unfamiliar regulatory environment;

an unfriendly legal and enforcement atmosphere that diminishes the use and acceptance of professional judgment because of fears of second-guessing by regulators and the plaintiffs bar;

a focus on detailed control activities by auditors; and

the lack of sufficient resources and competencies in an area in which companies and auditors have previously placed less emphasis.

But because of their different operating structures, smaller public companies have felt the effects of Section 404 in a manner different from their larger counterparts. With more limited resources, fewer internal personnel and less revenue with which to offset both implementation costs and the disproportionate fixed costs of Section 404 compliance, these companies have been disproportionately subject to the burdens associated with Section 404 compliance.

Accordingly, the Committee gave highest priority to a set of recommendations that would create a system of "scaled" securities regulation under which the smallest public corporations would be subject to less extensive disclosure and auditing requirements. In particular, the Committee recommended that the SEC exempt the smallest public corporations from SOX § 404, so long as they have a qualified audit committee and have adopted a qualifying code of ethics for disclosure and audit practices.

On May 17, the SEC responded by -- to be blunt -- tossing the Advisory Committee report in the circular file. Instead of even considering the Committee's detailed recommendations, which had gone well beyond the narrow problems created by § 404, the SEC announced a modest set of regulatory actions limited solely to § 404 issues. Even within those narrow confines, moreover, the SEC's plans can only be described as lame:

"The Commission expects to issue a Concept Release covering a variety of issues that might be the subject of Commission guidance for management. With the Concept Release, the Commission will solicit views on the management assessment process to ensure that the guidance the Commission ultimately proposes addresses the needs and concerns of all public companies. ... The Commission anticipates that this forthcoming guidance will help organizations of all sizes to better understand and apply the control framework as it relates to internal control over financial reporting. ... To ensure that this guidance is of help to non-accelerated filers and smaller public companies, the Commission intends that this future guidance will be scalable and responsive to their individual circumstances. ... The form of the guidance has yet to be determined." (Emphasis added.)

Subject to SEC oversight, the Public Corporation Accounting Oversight Board (PCAOB) will amend its auditing standards so as to reduce costs to companies by focusing auditor attention on "areas that pose higher risk of fraud or material error."

Small public corporations will get an extension on the date by which they are required to be fully compliant with § 404. "It is anticipated that any such postponement would nonetheless require all filers to comply with the management assessment required by Section 404(a) of Sarbanes-Oxley for fiscal years beginning on or after Dec. 16, 2006."

In sum, a couple of extra months before full compliance is required, a tweak to auditing standards that might reduce costs in one area, and unknown guidance to be provided in an unknown form.

Unlike the recommendations made by its own Advisory Committee, which would have provided significant and comprehensive regulatory relief for smaller public corporations, the SEC has taken a narrow and trivial approach to the problem. It's like using a band-aid to fix a gaping puncture wound.

Our capital market's bleeding thus is unlikely to be staunched by the SEC's action. Since SOX became law, our economy and capital markets have suffered from higher compliance costs in several ways:

The number of companies going private (so-called "going dark") has increased dramatically, with many firms citing SOX compliance costs as a principal reason for choosing to do so

A growing number of firms choosing to rely on retained earnings or private equity rather than raising money by going public via an IPO

Pre-SOX, 9 out of the ten largest IPOs had a US component; in the last year, 9 out of the 10 largest were entirely foreign

Fewer acquisitions and ADR offerings by foreign issuers

The bottom line? SOX is costing our economy the proverbial bundle and the SEC's response is little more than whistling past the graveyard.

05/30/2006

Pete Townshend comments on Won't Get Fooled Again being named the all time greatest "conservative" rock song:

... the song has no party-allied political message at all. It is not precisely a song that decries revolution - it suggests that we will indeed fight in the streets - but that revolution, like all action can have results we cannot predict. Don't expect to see what you expect to see. Expect nothing and you might gain everything.

Two thoughts: Revolution and conservatism are not necessarily inconsistent. From one perspective, for example, the American Revolution was a deeply conservative act - an attempt by the colonists to conserve what they understood to be the ancient rights of Englishmen from Parliamentary tyranny. Second, is not the law of unintended consequences, at the heart of the conservative worldview?

Further, Townshend opines:

The song was meant to let politicians and revolutionaries alike know that what lay in the centre of my life was not for sale, and could not be co-opted into any obvious cause. ... What I write is interpreted, first of all by Roger Daltrey. Won't Get Fooled Again - then - was a song that pleaded '….leave me alone with my family to live my life, so I can work for change in my own way….'. But when Roger Daltrey screamed as though his heart was being torn out in the closing moments of the song, it became something more to so many people. And I must live with that.

As for the political implications, note (1) the emphasis on there being an aspect of life which is not for sale, which echoes Edmund Burke's references to "the unbought grace of life," and (2) the desire to be left alone by both politicians and revolutionaries, so as to work for change individually, which echoes Burke's references to the "little platoons" of society, of which the family is first and foremost. As Ann Althouse thus correctly observes: "A lot of conservatives will say that's precisely what is conservative."

Finally, isn't this a fascinating insight into the complex relationship between Townshend and Daltrey? (For his own part, Daltrey has said that "Nothing ... challenges him like a Townshend song. Everything else, even the acting career, is 'secondary'.") The act of performance creates an entirely new work of art, whose meaning may be entirely different than that intended by the author/composer. Like revolution, performance thus "can have results we cannot predict."

Anyway, regardless of Townshend's, Daltrey's, or the song's politics, Won't Get Fooled Again stands as one of the great rock anthems of all time and, like all great works of art, is subject to appropriation and reinterpretation by those who hear (or view or read it).

Unlike the
recommendations made by its own Advisory Committee, which would have
provided significant and comprehensive regulatory relief for smaller
public corporations, the SEC has taken a narrow and trivial approach to
the problem. It's like using a band-aid to fix a gaping puncture
wound.

Everyone's pissed off over Jacob Weisberg's weird rant about Hillary Clinton's
iPod, and they're right to be. He basically used it as an
excuse to demonstrate that Hillary is exactly the conniving fake he
always thought she was, and it's likely he would have written the exact
same thing regardless of what songs had made her top ten list. It was a
remarkably lazy piece.

But I'm curious about something else: How do people even come up
with these top ten lists in the first place? I don't think I could do
it. That's not to say that I don't have any favorites. I do, and it
would be easy to prepare a list of ten pieces that I like a lot. But if
you asked me to do the same thing next week, there's a pretty good
chance that I'd choose an entirely different list.

Coming up with a list that has
stood the test of time actually is quite easy for iPod users. iTunes
automatically creates a playlist of your top 25 most frequently played
songs. Open that Playlist. Under the "File" menu, click
"Export Song List." This creates a text file you can then
edit. Mine's below the fold. No comments about how I'm an old fogey
stuck in "classic" rock & roll, please. Also, before you
throw the first stone, remember that you probably have some guilty
pleasures too.

Pete Townshend comments on Won't Get Fooled Again being named the all time
greatest "conservative" rock song:

... the song has no party-allied political message at all.
It is not precisely a song that decries revolution - it suggests that
we will indeed fight in the streets - but that revolution, like all
action can have results we cannot predict. Don't expect to see what you
expect to see. Expect nothing and you might gain
everything.

Two thoughts: Revolution and
conservatism are not necessarily inconsistent. From one perspective,
for example, the American Revolution was a deeply conservative act - an
attempt by the colonists to conserve what they understood to be the
ancient rights of Englishmen from Parliamentary tyranny. Second, is not
the law of unintended consequences, at
the heart of the conservative worldview?

Further, Townshend opines:

The song was
meant to let politicians and revolutionaries alike know that what lay
in the centre of my life was not for sale, and could not be co-opted
into any obvious cause. ... What I write is interpreted, first of all
by Roger Daltrey. Won't Get Fooled Again - then - was a song that
pleaded '?.leave me alone with my family to live my life, so I can work
for change in my own way?.'. But when Roger Daltrey screamed as though
his heart was being torn out in the closing moments of the song, it
became something more to so many people. And I must live with
that.

As for the political implications, note (1)
the emphasis on there being an aspect of life which is not for sale,
which echoes Edmund Burke's references to "the
unbought grace of life," and (2) the desire to be
left alone by both politicians and revolutionaries, so as to work for
change individually, which echoes Burke's references to the
"little platoons" of society, of which the family is first
and foremost. As Ann Althouse thus correctly observes: "A lot of conservatives will say
that's precisely what is conservative."

Finally, isn't this a fascinating insight into the complex
relationship between Townshend and Daltrey? (For his own part, Daltrey
has said that "Nothing ... challenges him like a Townshend song.
Everything else, even the acting career, is 'secondary'.") The act
of performance creates an entirely new work of art, whose meaning may
be entirely different than that intended by the author/composer. Like
revolution, performance thus "can have results we cannot
predict."

Anyway, regardless of Townshend's, Daltrey's, or the song's
politics, Won't Get Fooled Again stands as one of the great rock
anthems of all time and, like all great works of art, is subject to
appropriation and reinterpretation by those who hear (or view or read
it).

05/29/2006

"In a place like this, words fail; in the end, there can be only a dread silence, a silence which itself is a heartfelt cry to God: Why, Lord, did you remain silent? How could you tolerate all this?"

A perfectly valid question, of course, especially for a WWII veteran of the German army. As Pope John Paul II wrote of the problem of evil in Salvifici Doloris:

Man can put this question to God with all the emotion of his heart and with his mind full of dismay and anxiety; and God expects the question and listens to it ....

Even so, however, I would love to see a full transcript of Benedict's remarks, because his reported remarks bump up against a warning issued by JPII:

Why does evil exist? Why is there evil in the world? When we put the question in this way, we are always, at least to a certain extent, asking a question about suffering too.

Both questions are difficult, when an individual puts them to another individual, when people put them to other people, as also when man puts them to God. For man does not put this question to the world, even though it is from the world that suffering often comes to him, but he puts it to God as the Creator and Lord of the world. And it is well known that concerning this question there not only arise many frustrations and conflicts in the relations of man with God, but it also happens that people reach the point of actually denying God.

In Benedict's case, posing the question without also offering a reference to the answers worked out by Christian and Jewish scholars of theodicy opened the door to the press dragging up (1) Benedict's service in the German army and, worse yet, (2) the persistent canards about Pope Pius XII (refuted here and here, among others). Benedict cannot count on the rock star treatment the press gave JPII; Benedict can count on the press misreporting him, whether from malice or mere misunderstanding.

"We cannot peer into God’s mysterious plan - we see only piecemeal, and we would be wrong to set ourselves up as judges of God and history. Then we would not be defending man, but only contributing to his downfall. No - when all is said and done, we must continue to cry out humbly yet insistently to God: Rouse yourself! Do not forget mankind, your creature! And our cry to God must also be a cry that pierces our very heart, a cry that awakens within us God’s hidden presence - so that his power, the power he has planted in our hearts, will not be buried or choked within us by the mire of selfishness, pusillanimity, indifference or opportunism. Let us cry out to God, with all our hearts, at the present hour, when new misfortunes befall us, when all the forces of darkness seem to issue anew from human hearts: whether it is the abuse of God’s name as a means of justifying senseless violence against innocent persons, or the cynicism which refuses to acknowledge God and ridicules faith in him. Let us cry out to God, that he may draw men and women to conversion and help them to see that violence does not bring peace, but only generates more violence - a morass of devastation in which everyone is ultimately the loser. The God in whom we believe is a God of reason - a reason, to be sure, which is not a kind of cold mathematics of the universe, but is one with love and with goodness. We make our prayer to God and we appeal to humanity, that this reason, the logic of love and the recognition of the power of reconciliation and peace, may prevail over the threats arising from irrationalism or from a spurious and godless reason."

05/28/2006

Query: Is there a more anti-business/anti-capitalism "business
news" program than Jack Cafferty's "In the Money" on
CNN? As evidence for a "no" answer, I put forward Cafferty's
co
mments on the Enron verdicts:

So it
took the government a while but they got 'em. We're talking Skilling
and Lay, those two worms that were at the top of the Enron debacle. I
suppose some vindication in order for the people who lost their jobs,
their pensions, their hope for the future and everything else, because
of the malfeasance of these two clowns.

But the thing that
bothers me is they walked out of that courtroom on Thursday, they're
free men pending appeal, pending sentencing, pending, pending, pending.
I mean, why didn't they put them in those funny looking little orange
jump suits, slap some chains on them, and throw them in Leavenworth and
say, you know, if you win this on appeal, we'll let you out.

I have no wish to defend Lay and Skilling, but at
this point Lay and Skilling have only been allowed to remain out on
bail pending sentence. Besides making a factual misstatement about the
court's ruling, Cafferty also grossly misrepresents the rules governing
bail pending sentence or appeal. Under the federal bail reform act, a
trial court is not supposed to allow a convicted defendant to remain
out on bail pending sentence or appeal unless the court makes a
specific finding that he is not likely to flee or to pose a danger if
released, that the appeal is not for the purposes of delay, and that
the appeal has substantial merit. Hardly, a case of "pending,
pending, pending."

Then there's this comment from co-host Andy Serwer:

Yes, at some point, I guess, they are going to do some
hard time, Jack. And they are probably going to do the rest of their
lives in jail. I don't think it's very surprising, though, the
verdicts. And you know, to me, it's not that complicated. These guys
were in charge of this organization that just went belly up. They're
responsible and that's what the jury found out.

Note the naive assumption that we ought to criminalize agency
costs. Just "if the boat sinks on your watch, you go to
jail." For a more nuanced view, check out my article Are We
Criminalizing Agency Costs? Should You Care? In short, executives
who commit fraud ought to go to jail, but sending executives to jail
just because they were "in charge of this organization that just
went belly up" is just plain dumb:

The
problem is that business decisions rarely involve black-and-white
issues; instead, they typically involve prudential judgments among a
number of plausible alternatives. Given the vagaries of business,
moreover, even carefully made choices among such alternatives may turn
out badly.

If prosecutors, judges, and juries are unable to distinguish between
competent risk taking and criminal mismanagement, however, the threat
of criminal sanctions may discourage managers from taking risks.

Yet, risk-taking is precisely what shareholders want managers
to do. As the corporation's residual claimants, shareholders don't get
paid until all other claims on the corporation are satisfied. Because
risk and return are positively correlated, the high returns on
corporate investment necessary to leave something for the shareholders
require high risks.

The problem of criminalizing agency
costs should now be apparent. Obviously, shareholders want managers who
steal from the company or defraud investors to be punished. Yet, they
also want managers to take risks. If prosecutors and juries can't tell
the difference between the two, however, criminal sanctions may leave
shareholders worse off by making managers more risk
averse.

The problem with Cafferty and Serwer isn't
just that they're anti-business; it's that they're either too dumb or
too lazy to try understanding how business and the law work.

05/27/2006

I'm beginning to think that any idea that gets bipartisan support in Congress should be presumed to be a bad one. Consider the latest bipartisan effort:

A television shot of a little boy losing his dog during Katrina rescue operations was the catalyst for the House to pass legislation Monday that would require pets to be considered in emergency-preparedness plans. "The dog was taken away from this little boy, and to watch his face was a singularly revealing and tragic experience," said Rep. Tom Lantos, a California Democrat and sponsor of the Pet Evacuation and Transportation Standards Act. "This legislation was born at that moment." The bill, which passed 349-24, would require state and local preparedness offices to take into account pet owners, household pets and service animals when drawing up evacuation plans.

I'm a dog owner. I love my dogs dearly. In an emergency, I would strain every sinew to ensure their safety. But this is still a bad law.

First, there's the federalism issue. What is the federal connection here, other than the spending hook? The federal government is supposed to be a government of limited and defined powers. Pet evacuations simply don't rise to the level of the sort of national problems the federal government is supposed to deal with.

Second, this legislation sends a message that states and localities should expend resources to save pets in an emergency. Do we really want first responders spending time coaxing a scared dog onto a helicopter when they could be off saving people? Do we really want to spend taxpayer dollars on saving and sheltering pets instead of people? Money doesn't grow on trees and in a world of scarce resources, tragic choices have to be made.

I feel sorry for the kid who lost his dog, but not enough to make a federal case out of it.

A very fine young California Cabernet Sauvignon. Lots of berry and
black cherry flavors, plus a dash of oriental spice and anise. Firm
tannins and acids suggest good aging potential, but it works well now
with rich or spicy foods. Grade: B++

05/26/2006

Martha Stewart, who completed
a five-month prison sentence a year ago for lying about her sale of
ImClone stock, has decided to fight rather than settle civil insider
trading charges brought by the U.S. Securities and Exchange Commission.
In an 11-page response to the SEC complaint filed late Thursday with
the U.S. District Court for the Southern District of New York, Stewart
denied allegations that she used nonpublic information when she sold
3,928 shares of ImClone Systems Inc. stock in December 2001. Instead,
she said she "acted in good faith."

I've long
thought the SEC's insider trading argument was a bit of a stretch,
but I'm not sure I would have advised Martha to fight these charges. If
she goes to trial, the SEC is likely to seek the maximum fine, which is
disgorgement of her profits plus a fine equal to three times her
profits. Plus, the SEC may seek to bar her from service as a director
or officer of a public corporation. (Although I don't think the
Sarbanes-Oxley provisions making it easier for the SEC to do so can
apply retroactively to Martha's case.)

TransWorldNews announces release of audio interview with
Stephen Bainbridge, professor of securities law at UCLA. The audio
interview, conducted on May 25th, 2006 by TransWorldNews, has been
uploaded for listeners.

The seventeen minute interview with Bainbridge offers insight into
today?s verdict convicting top Enron executives Kenneth Lay and Jeffrey
Skilling of conspiracy to commit securities and wire fraud. Bainbridge
further discusseD the involvement of Andrew Fastow, Chief Financial
Officer of Enron, who pleaded guilty to conspiracy charges in January
2004. ...

05/25/2006

Gordon Smith joins Larry Ribstein and James Joyner in wondering why Jeffrey Skilling was convicted on all the fraud and conspiracy but acquitted on all but one of the insider trading counts:

So the question remains: how could he have been engaged in fraud during 2000, but not been engaged in insider trading?

As I explain in my book Insider Trading, there is a long standing debate as to whether a defendant can be convicted for trading while merely in the possession of material nonpublic information or whether the defendant must have traded on the basis of such information. In this case, the jury instructions specifically required the jury to find beyond a reasonable doubt that Skilling traded not just while possessing but also on the basis of material nonpublic information. The jury instructions further explained that this meant that the government had to prove beyond a reasonable doubt that Skilling "used the material, nonpublic information in making his decision to sell Enron stock." My guess thus is that Skilling had a sufficiently plausible explanation for most of the trades (excepting the last trade, as to which there apparently was some sort of smoking gun), such as plan of regular trading or some personal reason for selling when he did.

In fact, according to the jury instructions, as to the set of trades challenged in Count 50 of the indictment, Skilling claimed he had a plan for regularly selling securities, which the court described as constituting a potential "complete defense" for the trades in question. In any case, because of the distinction between trading on the basis of material nonpublic information and trading while in possession of such information, there is no necessary inconsistency between the verdicts.

The SEC long has argued that trading while in knowing possession of material nonpublic information satisfies Rule 10b-5’s scienter requirement. In United States v. Teicher, the Second Circuit agreed, albeit in a passage that appears to be dictum. An attorney tipped stock market speculators about transactions involving clients of his firm. On appeal, defendants objected to a jury instruction pursuant to which they could be found guilty of securities fraud based upon the mere possession of fraudulently obtained material nonpublic information without regard to whether that information was the actual cause of their transactions. The Second Circuit held that any error in the instruction was harmless, but went on to opine in favor of a knowing possession test. The court interpreted Chiarella as comporting with “the oft-quoted maxim that one with a fiduciary or similar duty to hold material nonpublic information in confidence must either ‘disclose or abstain’ with regard to trading.” The court also favored the possession standard because it “recognizes that one who trades while knowingly possessing material inside information has an informational advantage over other traders.”

The difficulties with the court’s reasoning should be apparent. In the first place, a mere possession test is inconsistent with Rule 10b-5’s scienter requirement, which requires fraudulent intent (or, at least, recklessness). In the second, contrary to the court’s view, Chiarella simply did not address the distinction between a knowing possession and a use standard. Finally, the court’s reliance on the trader’s informational advantage is inconsistent with Chiarella’s rejection of the equal access test.

In SEC v. Adler, the Eleventh Circuit rejected Teicher in favor of a use standard. Under Adler, “when an insider trades while in possession of material nonpublic information, a strong inference arises that such information was used by the insider in trading. The insider can attempt to rebut the inference by adducing evidence that there was no causal connection between the information and the trade—i.e., that the information was not used.”

Although defendant Pegram apparently possessed material nonpublic information at the time he traded, he introduced strong evidence that he had a plan to sell company stock and that that plan predated his acquisition of the information in question. If proven at trial, evidence of such a pre-existing plan would rebut the inference of use and justify an acquittal on grounds that he lacked the requisite scienter.

The choice between Adler and Teicher is difficult. On the one hand, in adopting the Insider Trading Sanctions Act of 1984, Congress imposed treble money civil fines on those who illegally trade “while in possession” of material nonpublic information. In addition, a use standard significantly complicates the government’s burden in insider trading cases, because motivation is always harder to establish than possession, although the inference of use permitted by Adler substantially alleviates this concern.

On the other hand, a number of decisions have acknowledged that a pre-existing plan and/or prior trading pattern can be introduced as an affirmative defense in insider trading cases, as such evidence tends to disprove that defendant acted with the requisite scienter. Dictum in each of the Supreme Court’s insider trading opinions also appears to endorse the use standard. In light of the Circuit split that now exists between Teicher and Adler, the Supreme Court may eventually have to resolve the conflict.

In 2000, the SEC addressed this issue by adopting Rule 10b5-1, which states that Rule 10b-5’s prohibition of insider trading is violated whenever someone trades “on the basis of” material nonpublic information. Because one is deemed, subject to certain narrow exceptions, to have traded “on the basis of” material nonpublic information if one was aware of such information at the time of the trade, Rule 10b5-1 formally rejects the Adler position. In practice, however, the difference between Adler and Rule 10b5-1 may prove insignificant. On the one hand, Adler created a presumption of use when the insider was aware of material nonpublic information. Conversely, Rule 10b5-1 provides affirmative defenses for insiders who trade pursuant to a pre-existing plan, contract, or instructions. As a result, the two approaches should lead to comparable outcomes in most cases.

Rule 10b5-1 may not have applied to all the trades in which Skilling allegedly committed insider trading. Alternatively, the trial court may have been persuaded that SEC Rule 10b5-1 should not apply to criminal cases. Indeed, at least in the Ninth Circuit, not only is proof use, not mere possession, required. The Ninth Circuit further held that in criminal cases no presumption of use should be drawn from the fact of possession—the government must affirmatively prove use of nonpublic information. United States v. Smith, 155 F.3d 1051 (9th Cir. 1998).

The Skilling trial court's pre-trial opinion denying Skilling's motion to dismiss the insider trading charges cited and discussed all the foregoing authorities, but did not attempt to resolve the discrepancies between them. Instead, the court simply held that it was "not persuaded that ¶ 120 fails to allege that he used material, nonpublic information when making the charged trades." At the very least, of course, this language does appear to adopt the use standard.

As we all know, the Enron decision was announced. And coming from someone who (as well as my wife) lost my job at Andersen as a result of this debacle, I wanted to share some of my thoughts about it.

Yes, I am very excited that Lay and Skilling were found guilty of all these charges. And yes, it is some vindication. But I will say that this whole mess, which I lay (no pun intended) at the feet of Bush and Cheney for reasons that I will get in to below, has had huge repercussions and a major impact on both my life and my wife's life as well, not to mention MILLIONS of Americans in so many ways. ...

Our (my wife and mine) anger was directed in a number of areas. First, while illegal activity is always wrong, Andersen was clearly the scapegoat for this widespread fraud.

Where to begin?

It is true that the Supreme Court unanimously overturned the Andersen conviction, but what clammyc doesn't tell you is that it do so on narrow legal grounds relating to the adequacy of the jury instructions, which had nothing to do with Arthur Andersen's culpability. The holding was not a mere legal technicality, but it also didn;t vindicate AA.

There is a case to be made against indicting an entire firm. But, as I wrote back in June of 2005, AA employees did not lose their job "for no reason":

Through the late-1990s, Andersen's name had figured prominently in various instances of business fraud by its clients, namely, Sunbeam, Waste Management Inc., Quest Communication, Global Crossing, and Baptist Foundation of Arizona. The firm faced civil charges for its supposed misrepresentation of accounts in most of these cases. The audit partners, who were involved in the audit of these companies were indicted and penalized by the SEC. In many of these cases, Andersen had settled investor claims, without acknowledging any fraud on its part ....

It's not like the government went after AA for a one-time slip-up. Instead, there was a repeated pattern of wrongdoing. I have my doubts as to whether that pattern justified killing off AA, which was the inevitable consequence of indicting - let alone convicting - the entity, but there also is no doubt in my mind that there was something very rotten at AA which needed to be cleaned out.

Given that history, it's disingenuous for clammyc to describe AA as "a friggin accounting firm that was never even accused of fraud or conspiracy."

George Bush didn't force AA to develop a firm-wide culture in which partners rampantly committed or facilitated fraud. George Bush didn't coerce AA into viewing paying legal damages for doing so as a cost of doing business. Put bluntly, there was a pattern of misconduct at AA that was, if not pervasive, at least very widespread.

Skilling was found guilty on 19 counts of conspiracy, fraud, false statements and insider trading. He was found not guilty on eight counts of insider trading.

Lay was found guilty on all six counts of conspiracy and fraud.

Quick Many thoughts, updated periodically and in no particular order:

Another victory for prediction markets: As I wrote back in April: "The latest contract at Tradesports for Lay to be convicted on at least 4 counts was 65.5 and for Skilling to be convicted on a whopping 16 or more counts was 66. In other words, roughly 1-2 odds in favor of conviction."

The acquittal of Skilling on some of the insider trading counts suggests the jury approached the issues with an open mind, contrary to defense claims that they could not get a fair trial in Houston.

It's not the crime, it's the cover up. The real crimes at Enron mainly consisted of turncoat government witness Andrew Fastow's shady deals, but Skilling and, especially, Lay are going down for improperly misrepresenting Enron's fortunes.

Mega-coverage by the Houston Chronicle's multiple blogs. The Chron's Enron blogs have been a breakthrough in showing how the MSM can make highly effective use of the new media when it wants to.

Lay will not be required to wear one of those electronic positioning ankle bracelets, but will not be allowed to leave the courthouse until he surrenders his passport. Query: Does surrendering your passport really make it all that hard for a wealthy guy to leave the country? Do you have to clear customs/immigration before taking a private plane flight out of the country? How about by yacht? I assume that the real problem is that a person without a passport would find it difficult to live abroad. But Andrew Luster managed to skip bail despite having surrendered his passport and being required to wear an ankle bracelet. Not that I think Lay or Skilling will skip. Just curious. [No illegal immigrant comments, please!]

One of the curious things about this case is the documented evidence that "a number of people were contradicting Enron's own rosy view of itself long before the middle of 2001." At what point does a lie by top management cease to matter if the market doesn't believe it? Presumably the government convinced the jury that people believed the lies Skilling and Lay told, but did the market really do so?

The Powers Report is still your "go to" document for background on the Enron mess. Here's what the Report says about Skilling with respect to one of the many related party transactions the company used to disguise expenses and losses: "As the magnitude and significance of the related party transactions to Enron increased over time, it is difficult to understand why Skilling did not ensure that those controls were rigorously adhered to and enforced. Based upon his own description of events, Skilling does not appear to have given much attention to these duties. Skilling certainly knew or should have known of the magnitude and the risks associated with these transactions. Skilling, who prides himself on the controls he put in place in many areas at Enron, bears substantial responsibility for the failure of the system of internal controls to mitigate the risk inherent in the relationship between Enron and the LJM partnerships."

Blogger/law prof Christine Hurt observes that the verdict came "as a surprise after journalists assumed that the jury would not come to a decision until after the holiday weekend." Maybe the jury wanted to enjoy the holiday? Or start wearing white shoes?

Blogger/law prof Larry Ribstein asks an interesting question about the acquittal of Skilling on most of the insider trading counts: "Does this mean that the jury thought he didn't know enough about what was happening to bar him from trading, but that he did know enough to go to jail for fraud?"

After the jury verdict was announced, the judge found Lay guilty on bank fraud charges that had been tried to the bench.

Will losing the Skilling case seriously harm star trial lawyer Daniel Petrocelli's reputation? (You'll recall that Petrocelli famously won the wrongful death suit against OJ Simpson, as documented in his book Triumph of Justice). The WSJ has free video of Petrocelli's reaction to the jury verdict.

According to news reports before the verdict: "Daniel Petrocelli and his law firm probably won't get fully compensated for their work defending Jeffrey Skilling, as the former Enron Corp. chief executive appears to have exhausted his defense fund. But the payoff down the road could be well worth it, even if Skilling is convicted. The decision to defend Skilling is seen as a calculated business move by Petrocelli and his Century City law firm, O'Melveny & Myers, to burnish their reputation and expertise in white-collar criminal defense."

It's the "even if Skilling is convicted part" about which I have questions.

Peter Lattman's identified two critical points that I suspect will quickly become (and correctly so) part of the conventional wisdom (or received learning, if you prefer):

"Credit the prosecutors for emphasizing narratives the jury could understand rather than focusing on complex tales of off-balance sheet partnerships and byzantine accounting." (Link)

" Lay’s testimony proved fatal. Everyone expected a charming, avuncular presence on the witness stand; instead, what they got was an argumentative, challenging, embittered man who refused to accept any personal responsibility for Enron’s collapse." (Link)

Over at Air America's blog, the first comment in a thread on the verdict is a message for Ken Lay: "While spending your final years in a Federal prison, as you are anally-probed by the huge throbbing member of your cellmate, I hope you think about your Enron traders laughing at the way they screwed the little ol' ladies in California out of their money."

It's not just the fringe, either. You'll recall that California Democratic attorney general attorney general Bill Lockyer said: "I would love to personally escort Lay to an 8-by-10 cell that he could share with a tattooed dude who says, 'Hi, my name is Spike, honey.'"

So is prison rape now part of the left's penal philosophy? [Update: Yes, pun intended.]

Apropos of which, see my TCS column Crime? And Punishment, which asked "Should Dennis Kozlowski spend the rest of his life worrying about prison rape?" More seriously, the column argues against criminalization as a solution to the agency cost problem in corporations.

Conservative (?) pundit's Tammy Bruce's reaction is more Old Testament than old school: "Let's hope some is left for the victims, while the Lay and Skilling families can reap what their men have sown on others - poverty and fear of the future." Cf. Deuteronomy 5:9-10 ("I, the LORD your God, am a jealous God, visiting the iniquity of the fathers on the children, and on the third and the fourth generations of those who hate Me, but showing lovingkindness to ... those who love Me and keep My commandments.")

To be sure, according to some scholars, the Old Testament passages in question suggest God will punish the children only if the children themselves are morally blameworthy. But Ms Bruce apparently doesn't think moral blameworthiness is necessary when it comes to the families of white collar criminals.

James Joyner is not surprised: "Jurors are composed of ordinary people who hold corporate titans in very low esteem. Unlike pop culture figures like singers and athletes, who tend to get a break from jurors awed by their celebrity, people hate CEOs."

Debates about the
Sarbanes-Oxley Act continue, but one thing is clear: its implementation
has created unintended consequences. As every Member of Congress knows
from many constituents, it has caused a tremendously expensive amount
of paperwork and bureaucracy. And the smaller the company, the greater
the proportional burden that has been
imposed.

Curiously, however, in today's W$J, James Quigley blithely opines
that:

A Small Business Advisory Committee
to the SEC recommended earlier this year that a majority of all public
companies be exempted from at least a portion of these requirements,
acting on a concern that the cost fell disproportionately on smaller
issuers. Members of Congress have also proposed legislation with
similar exemptions. The SEC has opted against such exemptions, instead
announcing a plan to substantially expand guidance to issuers,
and make other changes aimed at scaling implementation of these
requirements for smaller issuers. Concurrently, the PCAOB announced a
decision to revise a related audit standard.

... I believe that the SEC and PCAOB acted wisely,
shifting the debate to a discussion of how to make the law work
effectively for all companies and their investors. I believe that
costs, which have steadily declined in the past two years, can be
reduced further through SEC- and PCAOB-proposed
measures.

How can Quigley
take such a Panglossian view of the SEC's decision to throw the report
of its own advisory committee into the circular file? Easy, he's the
CEO of Deloitte & Touche USA LLP, one of the remaining big 4
accounting firms. SOX has been very good to accounting ... very good,
indeed, as Pollock explains:

Sarbanes-Oxley implementation caused separate engagements and
caused fees charged by accounting firms to soar dramatically. It thus
caused a profit bonanza for the partners of accounting firms at the
expense of corporate shareholders, who have absolutely no say in the
matter.

At the same time as the public accounting firms have received this
unintended, windfall enrichment, they have also become excessively
risk-averse and reluctant to give professional advice to their clients
on the application of America's complicated rules-based accounting
standards.

So forgive me if I'm unwilling to take
Mr. Quigley very seriously. Instead, I agree with Larry Ribstein:

Let?s face it: SOX,
and the compliance industry, are a gigantic leech on the back of
American industry. Quigley may be right that if we?re only patient
we?ll get used to this leech as we have to all the others, including
the 1933 Act. Industry grows around the leeches and adapts like the
body of the hapless character in the Kafka story. But that doesn?t mean
that we wouldn?t be better off if our blood was being put to more
productive uses.